What you know and what you must guess

• A debate is heating up on Central Bank Digital Currencies. We can easily see political and technical arguments stall their widespread adoption
• We explore what the Fed and the ECB “know”, and they must “guess”. The balance of signals is more supportive of an imminent pause in the US than in the Euro area.

Central banks’ digital currencies are usually seen as a non-contentious “compromise” providing the technical benefits of cryptos without their financial stability risks. The central bank community has been working positively, albeit prudently, on these issues, but some key players are clearly hesitant. Fed Governor Bowman produced last week a long list of arguments against CBDCs – even if she safely concluded her speech by a mere call for “more research”. Those who support CBDCs for their policy potential – the capacity to deal efficiently with the lower bound of central bank rates – may well underestimate the political and technical pitfalls. The risk that unlimited CBDCs would create for the banking system is recognized by most of their own advocates. This argument has probably gained in traction with the recent banking turmoil.

April has been quiet for the Fed and the ECB but as the market prepares for a much busier May we explore what the two central banks now “know” – the message sent by tangible data – and what they must “guess” – what they infer from recent developments. The balance of signals is different for the two central banks in our opinion. In the US, price data suggest core inflation is slowing down and the impact of the banking turmoil – although under control from a financial stability point of view – is already plain to see. It does not take “interpretative overreach” to conclude that a pause will be appropriate after “one last” hike in May. In the Euro area, it takes microscopes to detect a deceleration in core prices, while key indicators suggest the real economy is holding up well, potentially fuelling demand-led inflation. Credit data tell us that the monetary tightening is working its way, but “guesswork” is needed to substantiate an impact from the banking turmoil. Finally, while observed aggregate wages remain tame, recent industry-based pay deals (e.g., the very generous proposal in the German public sector) can be interpreted as signs that wages will soon replace profit margins as key inflation drivers. The idea that there is “more ground to cover” – and more than one rate hike left in this cycle – is easier to sustain in the Euro area than in the US.